Haig Bathgate: the obscure world of investment trust IPOs

The job of an investment manager is to be sceptical – I don’t take anything as read.

Therefore, when any segment of the market – whether industry, region or security – gets very positive press, I get wary. For me, one such segment is investment trusts.

Before I launch into the negatives, it is worth noting the positives of their structure. Operating with a fixed amount of equity capital enables managers to take a long-term approach to both investment and tax-related issues.

Fee downsides

One notable downside, however, is that as investment trusts’ prices are not fixed to the underlying asset value and will typically trade at a discount or premium, so the share price is more volatile than the underlying asset value.

This higher volatility has been exacerbated by the increased use of firm-wide wealth manager buy lists, where appearing on one can shift demand so high that it raises the premium, and a removal can widen the discount.

But by far the biggest problem I have with trusts is the high fees investors have to pay to access the funds at an initial share sale.

I was recently asked to participate in a fund launch, but I could not give it serious consideration, even though it might have been a good investment, because of the 2% fee that had to be paid just to buy the shares.

In other words, had I paid a pound of client money towards this fund, they would have ended up with an investment of 98p from day one.

For an investment that might display a discount to underlying value, the 2% charge raises the breakeven hurdle for me just that bit too far to make it worthwhile.

I realise that even with these fees there is still considerable demand for the funds.

Those more uniform buy lists I referred to earlier mean it is nigh on impossible for a large wealth manager to enter an investment trust in the secondary market because the liquidity just is not there.

Therefore the only access point available is at the initial public offering (IPO). But just because people are willing to pay a certain amount does not necessarily make it a good idea to charge them that.

I have no problem with people and businesses getting well paid to do a good job. The brokers who oversee the IPOs have to work hard to build up a list of potential investors and organise the marketing of these investments.

List of objections

So what are my objections?

First, the charges are too high and seem to be rising – I remember fund IPO charges at lower levels and some asset management companies historically covering the launch costs of new issues.

Second, the costs of marketing and selling a fund surely are fixed and not related to the amount of money that I spend on the investment.

I would prefer a flat fee that would allow the broker to make a reasonable profit after covering the expense of contacting me and dealing with my application.

Third, I am not quite sure of the service I am getting for this fee. Brokers used to hold investment trust shares on their books so as to create liquidity for a secondary market.

Following the financial crisis, they are limited in their ability to offer this facility, but fees seem to have been rising rather than falling as one would expect with a reduction in service.

In summary, I would like a fee that is linked to the service I am receiving and is broken down so I know exactly what I am paying for.

If my objections sound vaguely familiar it’s because they are: a more accountable and easily understandable process is at the heart of the retail distribution review (RDR).

Transparency is key

As an industry, we quite rightly insist that in our dealings with clients we charge a monetary amount that clearly and transparently covers the services we are offering.

This regulatory change was not about making the industry less profitable, but ensuring it is in the best possible position to operate efficiently and serve clients effectively.

There is no point in a clear and transparent process for clients operating alongside a system that is not clear for companies dealing with each other, especially when those companies are the agents of those clients.

So my criticism is measured.

Investment trusts broadly have a great deal to offer customers.

Show me a new investment trust with good prospects, a good manager and a clear, value-for-money fee structure, and there is a good chance I will buy into it.

I have no problem with people and businesses getting well paid to do a good job. The brokers who oversee the IPOs have to work hard to build up a list of potential investors and organise the marketing of these investments.

So, what are my objections?

First, the charges are too high and seem to be rising – I remember fund IPO charges at lower levels and some asset management companies historically covering the launch costs of new issues.

Second, the costs of marketing and selling a fund surely are fixed and not related to the amount of money that I spend on the investment. I would prefer a flat fee that would allow the broker to make a reasonable profit after covering the expense of contacting me and dealing with my application.

Third, I am not quite sure of the service I am getting for this fee. Brokers used to hold investment trust shares on their books so as to create liquidity for a secondary market. Following the financial crisis, they are limited in their ability to offer this facility, but fees seem to have been rising rather than falling as one would expect with a reduction in service.

In summary, I would like a fee that is linked to the service I am receiving and is broken down so I know exactly what I am paying for.

If my objections sound vaguely familiar it’s because they are: a more accountable and easily understandable process is at the heart of the retail distribution review (RDR).

Transparency is key

As an industry, we quite rightly insist that in our dealings with clients we charge a monetary amount that clearly and transparently covers the services we are offering.

This regulatory change was not about making the industry less profitable, but ensuring it is in the best possible position to operate efficiently and serve clients effectively.

There is no point in a clear and transparent process for clients operating alongside a system that is not clear for companies dealing with each other, especially when those companies are the agents of those clients.

So my criticism is measured.

Investment trusts broadly have a great deal to offer customers. Show me a new investment trust with good prospects, a good manager and a clear, value-for-money fee structure, and there is a good chance I will buy into it.

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